Bloomberg’s Cameron Crise is back, fresh off explaining how he’s a “risk taker” and unlike “pundits,” “risk takers” have to worry about their P/L and must therefore be honest with themselves (on occasion) about what’s working and what isn’t.
As it turns out, Crise’s “honest” assessment of his own holdings revealed that he was about half-right and about half-wrong with a dollop of “I don’t give a shit” thrown in vis-a-vis the greenback.
Tuesday afternoon found Crise feeling a bit introspective after a reader asked him to explain why he would want to own stocks 5% lower now when he didn’t want to own them at those levels when they were actually there.
That, Crise decided, “raised an interesting point” about the BTFD mentality.
So, he did some “reflecting” and you can find those “reflections” detailed below.
There are some good observations and some not-so-good observations in Crise’s piece, but I guess one thing I would encourage you to keep in mind as you read it is this bit from Deutsche Bank’s Dominic Konstam:
It is not that equities are cheap to bonds and therefore equities can keep rising and drag bond yields; instead it is that bonds are expensive to equities and by staying expensive can allow equities to become more expensive. Bonds serve as the crutch to the equity market.
And as soon as the demand supply dynamics in the bond market flip around, this will be abundantly clear.
Via Bloomberg
In chatting with a reader on Monday I mentioned that I thought a lot of people were looking for a 5% dip to buy, and that I had some sympathy for that view. “Why?” he retorted. “Would you like owning the SPX at 2325 more now than you did when it first got there?” Upon reflection, the answer is yes — but the reader’s question does raise an interesting point about the dip-buying mentality.
- If the post-crisis equity rally were to have a theme song, it would probably be called “just buy the dip.” The strategy has generally worked well, until recently, when there seem to have been no dips to buy.
- However, it’s not as if market fundamentals haven’t changed at all. The S&P 500 first eclipsed 2325 in mid- February, when economic enthusiasm was still strong. Anyone cautious about the prospects for either growth or the Trump agenda would have been proven absolutely correct in those views — and yet the market is still higher.
- It’s natural, therefore, not to want to pay the ding-dong high to add market exposure. Yet despite the erosion of the Trump trade, I’d argue that market fundamentals are stronger now than they were a few months ago.
- I’ve written before about my favorite market indicator, the real earnings yield. In late winter it appeared to be threatening the 1.5% level that I’ve identified as a boom/bust line for equity returns. Since then, however, it has risen nicely to a level of relative safety.
- At the same time, bond yields have fallen considerably, making equities look more attractive. If we look at the long term history of the real earnings yield minus the 10y Treasury yield, we see that the current level (0.54%) still looks very attractive. Obviously one needs to be careful in comparing nominal and real indicators, but it’s hard to escape the notion that stocks still look pretty attractive relative to bonds.
- About that dip, however — is there anything magical about the 5% decline threshold? No, of course not, and many very popular stocks fell by at least that much during the recent technology “crash.”
- We know that volatility clusters, so low vol today is typically followed by low vol tomorrow — but when it turns, it turns hard. Going back 60 years, I identified each all-time daily high in the S&P 500 and calculated the subsequent maximum one-month drawdown on a daily closing basis. I then normalized these into standard deviations using the trailing 40-day historical vol. In comparison to the normal distribution, you can see that there are a lot of very shallow drawdowns, and then more enormous ones than expected.
- Ultimately, this suggests that waiting for some arbitrary drawdown level is a bit like chasing a will-o-wisp. If you find securities that you like at a price you find attractive, it’s probably worth buying them rather than waiting for a sale that may or may not come. If you can’t find anything, then a modest dip probably won’t help that much.
- For what it’s worth, that 5% drawdown off of all-time highs over a 1-month horizon currently represents a 2.4 standard deviation event using current historical vols. There have only been 25 occasions over the last 60 years where this has occurred. Good luck with the wait.
